Wednesday, June 15, 2016

Analysis of RBI’s Draft Guidelines for On-tap Licensing of Universal Banks in the Private Sector

[The following guest post is contributed by Aditya Sood, who is a 4th year BA, LLB (Hons) student at the West Bengal National University of Juridical Sciences, Kolkata]

The Reserve Bank of India (RBI) on May 5, 2016 released Draft Guidelines for on-tap licensing of universal banks in private sector in India (“Draft Guidelines”).[1] The Draft Guidelines, if accepted, would mark a significant shift from the current “stop and go” policy of licensing of banks undertaken by RBI.[2] The guidelines envisage a “continuous authorization” policy with a view to “increase the level of competition” and “bring new ideas in the system”. This post looks at some of the key provisions of the Draft Guidelines and the issues that need to be addressed before these guidelines are accepted.

1.         Eligible Promoters

Under the Draft Guidelines, the following entities have been prescribed as eligible promoters: (i) existing non-banking finance companies (NBFCs) controlled by residents,[3] (ii) individuals or professionals who are residents and (iii) entities or groups in private sector owned and controlled by residents.

However, the Draft Guidelines specifically prohibit large industrial houses, which have diversified businesses, from being promoters of banks. These large industrial houses are defined in the Draft Guidelines as groups that have assets of Rs. 50 billion or more and the non-financial business of the group accounts for 40 per cent or more in terms of total assets or gross income. But these large industrial houses are permitted to hold up to 10 per cent equity in private banks through Individuals or companies connected with such large industrial houses. This limit of a maximum 10 per cent share will apply to individuals and all inter-connected companies belonging to the large industrial house on an aggregate basis. The objective of this provision is to prevent control of public money by large industrial or business groups that have diversified operations.

The promoters (whether individuals or entities) will have to fulfill the “fit and proper” criteria laid down by the RBI i.e. (i) minimum 10 years of experience in banking and finance (for individuals) or 10 years of experience in running their businesses (for entities and NBFCs), (ii) sound credentials and (iii) financial soundness and a successful track-record for at least 10 years. 

2.         Corporate Structure

The 2013 Guidelines for licensing of new banks (“2013 Guidelines”) mandated a Non Operative Financial Holding Company (“NOFHC”) model of corporate structure for a private sector bank. The basic objective of a NOFHC model is that the Holding Company should ring fence the financial activities (including the banking activities) of the promoter group from other activities not regulated by the financial regulators. The Draft Guidelines make a departure from the 2013 Guidelines by making the NOFHC model optional for individual promoters and standalone promoting or converting entities that do not have other group entities. Such promoters have been given the option of setting up or converting into a banking company under the Companies Act, 2013. However, for individuals or entities that have other group entities, the bank shall be set up only under the NOFHC model.

Corporate Structure of the NOFHC

The NOFHC has to be registered as a NBFC with the RBI. The minimum shareholding of promoters in the NOFHC has been fixed at 51 per cent of the total equity, which is lower than a wholly promoter-owned NOFHC under the 2013 Guidelines. This shows that RBI has permitted diversification of shareholding in the NOFHC. The Draft Guidelines prescribe the eligible shareholders of the NOFHC as, non-financial services companies, entities and NOFHCs, core investment companies, investment companies in the Group and individuals belonging to the Promoter Group. The shareholding of individuals belonging to the Promoter Group has been fixed at 15 per cent of the equity capital and shareholding by a single non-promoter individual shall not exceed 10 per cent of the equity capital.[4]

The Draft Guidelines state that only those regulated financial sector entities in which the individual promoter or Group has significant control will be held under the NOFHC. The determination of significant control will be done as per Accounting Standards AS 21 and AS 23.  

As per RBI’s mandate, there are certain activities such as, insurance, stock broking, mutual funds etc., which have to be conducted through a separate financial entity (other than the bank) under the NOFHC.[5] This separate entity could be a subsidiary, joint venture or an associate structure of the NOFHC. These entities are permitted to undertake only those activities that the bank is allowed to undertake under Section 6 (a) to (o) of the Banking Regulation Act, 1949.

3.         Minimum Capital requirement and Capital Adequacy Ratio (“CAR”)

The Draft Guidelines state that the initial minimum paid-up equity of the bank shall be Rs. 500 crore. The 2013 Guidelines also prescribed Rs. 500 crore as the minimum capital requirement for banks.

The initial minimum share of the promoters in the bank has been set at 40 per cent of the equity and if it is higher than 40 per cent then it has to be brought down to 40 per cent within 5 years of commencement of operations. The promoters’ share will remain locked-in for a period of 5 years from the commencement of operations. The Draft Guidelines provide for a gradual dilution of the promoter shareholding in the bank. The promoter share shall be brought down to 30 per cent of the equity within 10 years and to 15 per cent within a period of 12 years from date of commencement of business.

The Draft Guidelines also mandate the banks to maintain a minimum CAR of 13 per cent of the risk weighted assets (“RWA”) which is higher than the current CAR of 9 per cent of RWA for existing Scheduled Commercial Banks (“SCBs”).[6] The bank shall also list its securities on a stock exchange within 6 years of commencement of business.

4.         Foreign Shareholding of Banks

As per the Draft Guidelines, foreign shareholding in banks will be determined by the existing FDI policy. Presently, the Consolidated FDI Policy, 2015 prescribes for a maximum of 74 per cent of FDI in banking industry (up to 49 per cent through automatic route and after 49 per cent though approval of the Government).[7] Individual share of Foreign Institutional Investors (“FIIs”) or Foreign Portfolio Investors (“FPIs”) has been fixed at below 10 per cent of the paid up capital of the bank. Aggregate share of FIIs, FPIs and Qualified Institutional Investors (“QFIs”) cannot exceed 24 per cent of the total paid up capital of the bank and this limit can be raised up to 49 per cent through a resolution by the Bank’s Board of Directors followed by a special resolution to that effect by its General Body.[8]    

5.         Prudential and Exposure Norms

For a corporate structure without NOFHC, the prudential norms governing the new universal banks will be the existing norms on income recognition, asset classification and provisioning pertaining to advances, as specified by the RBI.  The banks are also prohibited from having any exposure to its promoters who have a shareholding greater than 10 per cent of the equity capital. The exposure norms will be the existing permissible exposures allowed by the RBI.

For a bank with a NOFHC structure, the prudential and exposure norms are same as prescribed in the 2013 guidelines in paragraphs 2 (G), (H) and (I). The earlier guidelines state that prudential norms will be applicable to the NOFHC both on a stand-alone and a consolidated basis and the norms will be on similar lines with the bank. The NOFHC and the bank are precluded from having any exposures to the Promoter Group and the banks are prohibited from investing in the equity or debt capital instruments of any financial entities held by the NOFHC.

6.         Other conditions

The applicants are required to submit a realistic and viable business plan along with their applications. It should state how the bank proposes to achieve the financial inclusion and should consist of a project report containing details about various aspects provided in Annexure II of the Draft Guidelines.

Further, the banks are required to comply with the priority sector lending targets as applicable to domestic banks. The present rate for priority sector lending is 40 per cent of the Adjusted Net Bank Credit or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher for domestic scheduled banks.

The Draft Guidelines also mandate the banks to open at least 25 per cent of its branches in unbanked rural areas.

7.         Issues that need to be addressed

First, the Draft Guidelines nowhere provide for a time limit within which the application has to be accepted or rejected by the RBI. The RBI also does not need to provide any reasons for the rejection of application. There should be some provision in the Draft Guidelines to limit the time period for assessment of applications.

Second, the Draft Guidelines in paragraph 2(I)(xiii) state that

“Banking being a highly leveraged business, licences shall be issued on a very selective basis to those who conform to the above requirements, who have an impeccable track record and who are likely to conform to the best international and domestic standards of customer service and efficiency. Therefore, it may not be possible for RBI to issue licences to all the applicants just meeting the eligibility criteria prescribed above

This basically implies that even though theoretically RBI is shifting to on-tap licensing, however it will still have the final discretion to grant or reject a license even though an applicant fulfills all the criteria mentioned above. This provision defeats the purpose of on-tap licensing and makes it discretion based instead of being rule based.

The RBI has invited comments on the Draft Guidelines till June 30, 2016 and if the above issues are addressed, it would help in fulfilling the objective for which these guidelines were introduced.

- Aditya Sood

[2] According to the current policy, the RBI opens application for licenses of banks once in a decade and grants licenses to suitable applicants. The most recent round of granting licenses happened in 2013 where RBI granted licenses to IDFC Bank and Bandhan Financial Services.

[3] As defined in the relevant Foreign Exchange Management Regulations.

[4] Here individuals include their relatives as defined under Section 2(77) of the Companies Act, 2013 and other entities where individual and/or his relatives hold not less than 50 per cent of the voting equity shares.

[5] See RBI FAQs on Guidelines for Licensing of New Banks in the Private Sector, Question 86, available at

[6] Master Circular on Prudential Norms on Capital Adequacy (UCBs), published on July 1, 2015 available at

[7] Department of Industrial Policy and Promotion, Consolidated FDI Policy, 2015, at 68.

[8] Id.

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